Project Outline
Project Outline Executive Summary - 1 page - paper clipped to report - highlights of forecast I. Introduction (2 pages) ''' '''A. Purpose of report; why it's important; audience Preetha B. Structure - background & forecast Preetha C. Highlight important points for the reader II. Background Analysis since 2000 and Current Situation A. The Economic Environment (see above questions) (7 pages) (Robert) ' 1. GDP and Inflation' ' 2. Production' ' 3. Spending (CIGXM and Federal Reserve)' ' 4. Forces and Trends relevant for Industry & Firm' B. Industry (see above questions) (7 pages) ' 1. Description of Industry Katie' Few inventions have changed how people live and experience the world as much as the invention of the airplane. During both World Wars, government subsidies and demands for new airplanes vastly improved techniques for their design and construction. Following the World War II, the first commercial airplane routes were set up in Europe. Over time, air travel has become so commonplace that it would be hard to imagine life without it. The airline industry, therefore, certainly has progressed. It has also altered the way in which people live and conduct business by shortening travel time and altering our concept of distance, making it possible for us to visit and conduct business in places once considered remote. (For more on the airline industry, read Is That Airline Ready For Lift-Off?) The airline industry exists in an intensely competitive market. In recent years, there has been an industry-wide shakedown, which will have far-reaching effects on the industry's trend towards expanding domestic and international services. In the past, the airline industry was at least partly government owned. This is still true in many countries, but in the U.S. all major airlines have come to be privately held. The airline industry can be separated into four categories by the U.S. Department of Transportation (DOT): *International - 130+ seat planes that have the ability to take passengers just about anywhere in the world. Companies in this category typically have annual revenue of $1 billion or more. *National - Usually these airlines seat 100-150 people and have revenues between $100 million and $1 billion. *Regional - Companies with revenues less than $100 million that focus on short-haul flights. *Cargo - These are airlines generally transport goods. Airport capacity, route structures, technology and costs to lease or buy the physical aircraft are significant in the airline industry. Other large issues are: *Weather - Weather is variable and unpredictable. Extreme heat, cold, fog and snow can shut down airports and cancel flights, which costs an airline money. *Fuel Cost - According to the Air Transportation Association (ATA), fuel is an airline's second largest expense. Fuel makes up a significant portion of an airline's total costs, although efficiency among different carriers can vary widely. Short haul airlines typically get lower fuel efficiency because take-offs and landings consume high amounts of jet fuel. *Labor - According to the ATA, labor is the an airline's No.1 cost; airlines must pay pilots, flight attendants, baggage handlers, dispatchers, customer service and others. Airlines also earn revenue from transporting cargo, selling frequent flier miles to other companies and up-selling in flight services. But the largest proportion of revenue is derived from regular and business passengers. For this reason, it is important that you take consumer and business confidence into account on top of the regular factors that one should consider like earnings growth and debt load. (For more about the consumer confidence survey, see Economic Indicators: Consumer Confidence Index.) Business travelers are important to airlines because they are more likely to travel several times throughout the year and they tend to purchase the upgraded services that have higher margins for the airline. On the other hand, leisure travelers are less likely to purchase these premium services and are typically very price sensitive. In times of economic uncertainty or sharp decline in consumer confidence, you can expect the number of leisure travelers to decline. It is also important to look at the geographic areas that an airline targets. Obviously, more market share is better for a particular market, but it is also important to stay diversified. Try to find out the destination to which the majority of an airline's flights are traveling. For example, an airline that sends a high number of flights to the Caribbean might see a dramatic drop in profits if the outlook for leisure travelers looks poor. A final key area to keep a close eye on is costs. The airline industry is extremely sensitive to costs such as fuel, labor and borrowing costs. If you notice a trend of rising fuel costs, you should factor that into your analysis of a company. Fuel prices tend to fluctuate on a monthly basis, so paying close attention to these costs is crucial. Porter's 5 Forces Analysis #Threat of New Entrants. At first glance, you might think that the airline industry is pretty tough to break into, but don't be fooled. You'll need to look at whether there are substantial costs to access bank loans and credit. If borrowing is cheap, then the likelihood of more airliners entering the industry is higher. The more new airlines that enter the market, the more saturated it becomes for everyone. Brand name recognition and frequent fliers point also play a role in the airline industry. An airline with a strong brand name and incentives can often lure a customer even if its prices are higher. #Power of Suppliers. The airline supply business is mainly dominated by Boeing and Airbus. For this reason, there isn't a lot of cutthroat competition among suppliers. Also, the likelihood of a supplier integrating vertically isn't very likely. In other words, you probably won't see suppliers starting to offer flight service on top of building airlines. #Power of Buyers. The bargaining power of buyers in the airline industry is quite low. Obviously, there are high costs involved with switching airplanes, but also take a look at the ability to compete on service. Is the seat in one airline more comfortable than another? Probably not unless you are analyzing a luxury liner like the Concord Jet. #Availability of Substitutes. What is the likelihood that someone will drive or take a train to his or her destination? For regional airlines, the threat might be a little higher than international carriers. When determining this you should consider time, money, personal preference and convenience in the air travel industry. #Competitive Rivalry. Highly competitive industries generally earn low returns because the cost of competition is high. This can spell disaster when times get tough in the economy. ' 2. Size of Industry relative to economy Esther' ' 3. Market Structure - description of firms Shiwali' The airlines industry is an oligopoly with monopoly pricing at major hubs. With few major airlines, they have a considerable amount of power to set prices for their amount of supply. “There are mainly three types of airlines-major, national, and regional. Major carriers are the largest carriers with domestic and international routes and the largest market share. National carriers focus on concentrated routes. Regional carriers are the most numerous but with the smallest market share and fly smaller aircrafts on thinly travelled routes primarily feeding passengers into the larger routes. After deregulation in 1978, there was a rash of mergers leading to fewer airlines and greater oligopoly. Since then low-cost airlines and national and regional airlines have expended and eating into the market share for the larger carriers. In turn the larger carriers have increased mergers further reducing the number of major airlines and increasing the magnitude of single-firm dominance. A few non-major airlines also operate independently as close affiliates of the major airlines. Non-major airlines have gained some market share in light of financial problems major carriers faced. Alliances and affiliations link carriers with each other. Operating agreements link regional airlines acting as feeder service to major airlines. Because of these cooperative agreements, truly independent number of suppliers is lower in the industry as compared to the number of airlines. Major airlines have also formed cooperative agreements in which they use each others scheduling, ticketing and marketing partnerships. Airlines have also formed global alliances with major foreign airlines that has evolved into international groupings. These affiliations require extensive cooperation among potential rival airlines. This suggests that effective decision making in the airline industry is greater than the firm’s individual share would indicate. There are several barriers that limit the entrance of new carriers. Major airports are accessible only to carriers holding governments slots. These permits were originally allocated to the dominant airlines and the airlines have maintained or even increased their share of the permits. Second the dominant carriers exert control over the facilities usage at the airports through agreements with local airport authorities. Third, the major airlines have used the computer reservation and ticketing systems to their benefit by manipulating the onscreen presentation of flights and incentives to travel agents. Fourth, major carriers can use their lobbying power to create additional barriers to competition. Mutual interdependence enables the airlines to fly with tight pricings. " ' 4. Production (costs, economies of scale, constraints on inputs)' Katie 2000 - Jet-fuel prices have doubled in 12 months, labor costs are up sharply, and passenger revenue has weakened as the big carriers have added planes to the skies faster than demand warrants. fourth-quarter operating earnings for the 10 major airlines are expected to be down 22% because of oil and light turn-of-the-millennium bookings. This year, airlines will pay about $4 billion more for jet fuel than in 1999, predicts David Swearinga, chief economist at the Air Transport Association, a trade group. But the increase will continue to be partially offset by productivity gains, and as a whole, the industry is expected to earn about $3.5 billion in 2000, according to Mr. Swearinga's preliminary estimates. The shift reflects widespread changes in almost every area: How tickets are sold, how passengers are seated and fed, and how planes and gate agents are allocated. Carriers are now squeezing more dollars out of each airline seat while cutting costs elsewhere. And new projects promise even more substantial savings. 2006 - Despite the burden of record fuel prices, major U.S. airlines are staging a recovery from five years of brutal losses, something many analysts and airlines didn't think possible as recently as six months ago. The six largest legacy carriers -- AMR Corp.'s American, Continental Airlines, Delta, Northwest Airlines, UAL Corp.'s United Airlines and US Airways Group -- are putting far fewer planes in the sky these days, streamlining their fleets and pushing up prices where they can. New statistics for 2005 show those airlines had a combined mainline operating fleet of 2,747 aircraft, down 21% from the 3,469 they had at the end of 2000, according to the Air Transport Association. A new surge in fuel prices could offset the recent fare increases, and renewed pricing power could tempt airlines to raise fares so high that demand begins falling. For some airlines it still could be another year before the increased revenue translates to profits. And more restructuring is bound to occur. Some U.S. airline executives worry that 2006 might be a peak year for their historically cyclical industry, giving airlines little time to prepare for another downturn. William Warlick, airline analyst at Fitch Ratings, says that while capacity is down, the industry still has too many airlines. "In the next downturn, the industry will still be vulnerable to irrational capacity behavior and pricing actions," he said. Behind the scenes some carriers are further improving margins with more sophisticated pricing strategies and by employing a new generation of so-called origin-and-destination, or O&D, revenue-management systems. Those systems are designed to reduce the number of inexpensive -- and unprofitable -- seats that travelers can find on the Internet. Delta, the third-largest U.S. carrier, credits a computerized system called OMNI, which it launched in February 2005, for improving its revenue. 2009 - Airlines' chronic problem is familiar to any Econ 101 student: Too much supply -- of planes and seats -- chasing too little demand. In some industries, discounts jump-start demand, lifting sales volumes and boosting profits. For airlines, "lower pricing doesn't necessarily boost revenue," says David Swierenga, who runs AirEcon, a consulting firm in Vienna, Va. The demand airlines need is from passengers who can pay fares that are high enough to cover carriers' costs. For fliers, that glut means bargains. Unsold tickets are useless once an airplane door closes. When carriers get desperate, they ignore their costs and instead scramble for cash by dropping prices. "Competition does bring down prices, which brings down profitability," says Peter Morris, chief economist at Ascend Worldwide, an aviation-consulting firm in London. "But speaking as a consumer, I say, 'Hooray,' " he adds. The airline industry has exhibited disecono mies of scale as the largest carriers higher average costs and lower productivity. This market characteristic became more pronounced following the 09/11 terrorist attacks. Smaller, lost-cost airlines have been able to operate at a greater efficiency over the past decade or so. Due to larger airlines having been established for a longer period of time, their employees have become more specialized and therefore, come with a higher cost of labor. With unions dominating the U.S. airline field, the market tends to illustrate a coalescence of firms dominating the output market and labor organizations dominating inputs. Experts have determined that low-cost airlines operate among more efficient processes as well. Specifically, these smaller airlines utilized only one or two types of aircraft as part much simpler fleet. As a result, maintenance and parts operations were simplified which enhanced the flexibility of crews and crew assignments. This in turn, allows smaller carriers to keep production and maintenance costs relatively low by comparison. In contrast, large carriers operate with a fleet of varying aircrafts which require complex crews both in numbers and specialization for parts and maintenance. According to reports filed with the Department of Transportation in 1999, airline costs were as follows: Flying Operations - essentially any cost associated with the operation of aircraft, such as fuel and pilot salaries - 27 percent; Maintenance - both parts and labor - 13 percent; Aircraft and Traffic Service - basically the cost of handling passengers, cargo and aircraft on the ground and including such things as the salaries of baggage handlers, dispatchers and airline gate agents - 16 percent; Promotion/Sales - including advertising, reservations and travel agent commissions - 13 percent; Passenger Service - mostly in-flight service and including such things as food and flight attendant salaries - 9 percent; Transport Related - delivery trucks and in-flight sales - 10 percent; Administrative - 6 percent; Depreciation/Amortization - equipment and plants - 6 percent. Labor costs are common to nearly all of those categories. When looked at as a whole, labor accounts for 35 percent of the airlines' operating expenses and 75 percent of controllable costs. Fuel is the airlines' second largest cost (about 10 to 12 percent of total expenses), and travel-agent commissions is third (about 6 percent). Commission costs, as a percent of total costs, have recently been declining, as more sales are now made directly to the customer through electronic commerce. Another rapidly rising cost has been airport landing fees and terminal rents. ' 5. Demand (factors affecting demand, substitutes & complements, elasticities) Shiwali' A characteristic of demand is the urgency of the trip and the flexibility of the flyer’s schedule. Leisure travellers are more elastic and sensitive to price. They look for substitutes and more options as the fare price increases. Business travellers have a low elasticity as they often have to travel on short notice. Airlines use price-discrimination to use the different elasticities to their advantage. Though in recent years, business travellers are becoming more inelastic and airlines are experimenting with lower fares. Studies have indicated that another variable that factors into the elasticity for airline ticket price is length of the trip. The use of cars, buses, and trains is a substitute service that can be utilized in place of shorter airline flights. Therefore, shorter distanced airline ticket prices tend to be much more elastic than those of long-distance trips. To counter, long-distance flights have far less substitutes, particularly international travel in which large bodies of land or water must be covered. Research industries have estimated the price elasticity for long-haul international business at -0.26% while long-haul international leisure trips have a calculated elasticity at -0.99%. Likewise, long-haul domestic business trip elasticity was calculated to be -1.15% while long-haul domestic leisure trips were -1.15%. This provides a direct correlation between the length covered for a flight, in addition to the particular type of trip, and the percent quantity demand. Thus, we can conclude that traditionally, international flights have been more inelastic than those of more elastic-based domestic flights. Katie - From a 2006 article: In the first two months of this year, domestic available seat miles, a measure of U.S. industry capacity, dropped 2.8% to 113.2 billion from 116.5 billion a year earlier, while U.S. airlines filled more seats -- 74.3%, up from 70.7%. With the cuts in capacity and strong demand, big airlines are enjoying their strongest pricing power in five years, and for the first time the ability to pass on a substantial share of lofty fuel costs to their customers. In some cases the total revenue has increased with increased passengers. In other cases the total revenue remains the same with lower price and increased quantity. Airfare is a normal good. As the number of passengers increases, there is a greater demand for seats. Future expectation is that prices are not going to decrease anytime soon. For distances of 300 miles or more, no close substitutes exist. When oil prices rise, airfare tickets also rise as they are complementary goods and have positive cross-price elasticity. Airline travel is still a luxury thus has a positive income elasticity. Marginal revenue increases at a decreasing rate. C. Firm (see above questions) (7 pages) ' 1. Market Power, strategies, goals' ' 2. Production' Mike 2009 - U.S. airlines, which struggled for the past decade, have led the industry in adapting. When oil prices soared last spring, American carriers slashed their fall schedules and fleets to cut expenses. Then fuel costs plunged, but demand did, too. Thanks to the precautionary cuts, U.S. airlines -- perhaps for the first time ever -- were braced in crash position when their market tanked last fall. European and Asian carriers belatedly followed. ' 3. Demand' Mike III. Forecast/Projections/Recommendations (2 pages) A. The Economic Environment - describe the forces and trends that are most important. The macroforecast should include specific ranges for the growth of GDP and the components; inflation, and shortand 'long-term interest rates.' B. Industry C. Firm ' '1. Reaction to macro changes and effect on strategy ' 2. Reduce costs of production (changes in inputs or scale of production)' ' 3. Develop a new product or expand into another area of the market'